Is the reserve currency status of the US Dollar a privilege or a burden? Michael Pettis suggests the latter and argues in favor of constraining unlimited purchases of US or other government bonds by international trading partners like China and Japan:
…it is actually quite easy to list the conditions under which reserve currency status encourages growth and the conditions under which it forces a rise either in debt or in unemployment. In advanced countries with deep and flexible financial markets, except in the case in which capital has become severely constrained by the need for money to be backed by gold, or real interest rates have been forced up to extremely high levels in order to break inflation as was the case in the late 1970s and early 1980s, the net inflows associated automatically with reserve currency status will not result in an increase in productive investment. They only result in an increase either in debt or in unemployment.
This is not an argument in favor of returning to gold, by the way. It is completely neutral on the issue. This argument simply restates the Keynesian insight that eliminating the discipline imposed by the gold standard is likely to become destabilizing unless there is another way to impose discipline…..
….the potentially destabilizing effect is no longer so distant. In a recent essay I tried to show that if we have not already reached the point at which the dominant reserve currency status of the US dollar is harmful to the US and potentially destabilizing to the world, logically we will inevitably reach that point, and probably soon….
I have frequently argued that capital account inflows into US Treasuries artificially inflate the dollar, give trading partners a competitive advantage, and cause the loss of millions of manufacturing jobs. Failure to address this issue is one of the major causes of low wage growth and rising inequality in the US.
Read more at Are we starting to see why its really the exorbitant “burden” | Michael Pettis' CHINA FINANCIAL MARKETS.
Hi Colin,
you have again highlighted an interesting situation. If what I have been reading about China’s ambitions in this area is correct then we may well see a challenge to the US. Rumor has it that China is amassing massive gold reserves so that its Yuan can compete on equal terms for reserve currency status. If the US was to lose or have to share their current lofty position I wonder what would happen next?
As Michael Pettis points out in his article, China is headed at full-speed in both directions. Unwinding of their US Treasury holdings would turn the tables, raising the yuan to an uncompetitive level vis-a-vis the Dollar.